Chapter 1 - Introduction
1.1 The possibility of allowing families with children to split their income for tax purposes is the subject of this discussion document, which is a direct result of a commitment made in the confidence and supply agreement between Labour and United Future.
1.2 The New Zealand tax system works on an individual basis, meaning that individuals are taxed on the income they earn. Income splitting, in its simplest form, would treat the family rather than the individual as the taxable unit. Family income would be split equally between parents for tax purposes, which would mitigate the effect of progressive tax rates – resulting in tax savings for many families.
1.3 The discussion document invites readers’ views on whether introducing income splitting of the kind discussed here would be the best way to provide additional government support for families with children, provided they think additional support is needed. And if income splitting is not the answer, what other options should be considered?
1.4 The discussion document limits its consideration of income splitting to families with children, even though several countries allow income splitting for all couples. There are two reasons for that limitation: first, supporting families with children is one of the main priorities for this government, and, second, the fiscal cost of allowing income splitting for all couples would be very high.
Working for Families tax credits
1.5 Working for Families tax credits are the most notable way in which the government provides support for families with children. These tax credits help families by targeting support on the basis of family income. The level of support provided depends on the number and age of children in the family and whether the family is in work. As a result, Working for Families provides equal support to families that have the same family income, work status and number and age of children.
1.6 By the end of last year about 360,000 families were receiving assistance through Working for Families. On average, each family received $5,600 in assistance.
Choices for families
1.7 The government is also committed to providing real choices to parents and carers in combining their work with their caring roles. Its “Choices for Living, Caring and Working” ten-year action plan, developed in 2006, involves initiatives in a number of areas that meet the needs of families as they move through their lives. These include parental leave, early childhood education, out-of-school services, the development of a carers’ strategy, and encouraging flexible work practices.
1.8 By helping single-earner families, income splitting may enhance the choices available to parents by helping to ensure that it is a viable option for one parent to stay at home, or work part-time, to care for their dependent children.
How income splitting would work
1.9 There are two broad ways to achieve income splitting for tax purposes. The first is to aggregate family income and (as the name suggests) split it evenly between the two partners. Total tax liability would then be determined by applying the tax rate schedule to the split level of income.
1.10 That would mean, for example, that a family with one partner earning $80,000 a year and the other partner earning $20,000 a year would be taxed as if both partners earned $50,000 a year. Thus the highest tax rate applying to their joint income would be 33%, rather than the top rate of 39% that the high earning partner would attract under individual taxation. That would mean a tax saving of $3,360 a year for the family.
1.11 The second way of achieving income splitting, and with the same effect, would be to provide a separate tax rate schedule for families, one where the tax-rate thresholds were twice as high as the thresholds that apply for an individual.
1.12 Whichever method was used, allowing income to be split on a 50/50 basis would change the taxable unit from the individual to the couple or family.
1.13 Possible variations of income splitting might include income splitting by more than two family members – for example, by including dependent children, elderly and disabled family members. There might also be a case for allowing only a 70/30 or 60/40 split rather than a 50/50 split.
1.14 Other important questions are how “family” should be defined for purposes of income splitting; what age restriction should be placed on children in the family for it to qualify for income splitting; and whether income splitting should be optional or compulsory.
1.15 These considerations are discussed in chapter 3, which outlines a possible approach to income splitting for New Zealand.
1.16 Chapter 4 looks at the impact of income splitting on families in terms of who would benefit financially and how effective marginal tax rates would change as a result of income splitting.
Criteria for assessing income splitting
1.17 Chapter 5 discusses the merits of income splitting against a set of criteria, including whether it would be complementary to the government’s “Choices for Living, Caring and Working” action plan.
1.18 The main criterion, however, is fairness: would the introduction of income splitting for families with children lead, at a reasonable fiscal cost, to a fairer outcome for families than is currently the case?
1.19 It is debateable whether the introduction of income splitting would be fairer on families with children. That is highlighted in the example of two families with one child of the same age. Both families earn $100,000 in total, but in Family 1 each partner earns $50,000, while in Family 2 one partner earns $100,000 and the other is not in paid employment. These families will receive the same level of support through Working for Families, but Family 2 will face a higher tax burden under the present system because some of its income is taxed at a higher rate than Family 1’s income. If income splitting were to be adopted, Family 2 would pay less tax than it does now.
1.20 On the other hand, perhaps Family 2 is better able to pay more tax than Family 1 and so should face a higher tax burden. It may be that the partner in Family 2 who is not in paid employment is able to engage in valuable activities at home, such as full-time childcare, which neither partner in Family 1 can do.
1.21 Other important criteria are:
- Efficiency – would income splitting bias people’s decisions to produce, consume, work, save and invest?
- Simplicity – would income splitting be easy to understand and comply with, or would it create significant additional compliance costs for people?
- Administrative costs – would income splitting be compatible with the current tax system, and would it be costly to implement and administer?
Timing of any possible changes
1.22 If submissions show strong support for allowing income splitting for families with children, the government will look at developing detailed proposals for further consideration, although that would not occur until early in 2009.
How to make a submission
1.23 The government invites submissions on the questions posed in this discussion document, as well as those on any other measures that could support families with children.
Special points for submissions
The government invites readers’ views on the following matters:
- Is income splitting the best way to provide additional support for families with children?
- If not, what other options could be considered to provide additional support for families with children?
If income splitting is favoured:
- Should the split be on a 50/50 basis, a 70/30 basis or in some other way?
- How should a “family” be defined?
- What restrictions should be placed on the children’s ages for a family to be eligible?
- Should it be optional or compulsory?
1.24 Submissions should be made by 30 June 2008 and can be addressed to:
C/- Deputy Commissioner
Policy Advice Division
Inland Revenue Department
PO Box 2198
Or email: [email protected] with “Income splitting” in the subject line.
1.25 Submissions should include a brief summary of major points and recommendations. They should also indicate whether it would be acceptable for officials from Inland Revenue and the Treasury to contact those making submissions to discuss their submission, if required.
1.26 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their publication. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Accordingly, those making a submission who think that any part of it should be properly withheld under the Act should indicate this clearly.